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Dynamics and monetary policy in a fair wage model of the business cycle

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Abstract

We first build a fair wage model in which effort varies over the business cycle. This mechanism decreases the need for other sources of sluggishness to explain the observed high inflation persistence. Second, we confront empirically our fair wage model with a New Keynesian model based on the standard assumption of monopolistic competition in the labor market. We show that, in terms of overall fit, the fair wage model outperforms the New Keynesian one. The extension of the fair wage model with lagged wage is judged insignificant by the data, but the extension based on a rent sharing argument including firm’s productivity gains in the fair wage is not. Looking at the implications for monetary policy, we conclude that the additional trade-off problem created by the inefficient real wage behavior significantly affect nominal interest rates and inflation outcomes. JEL Classification: E4, E5.

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 780.

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Length: 49 pages
Date of creation: Jul 2007
Date of revision:
Handle: RePEc:ecb:ecbwps:20070780

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Keywords: Efficiency wage; effort; inflation persistence; monetary policy.;

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Citations

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Cited by:
  1. Jean-Pierre Danthine & André Kurmann, 2010. "The Business Cycle Implications of Reciprocity in Labor Relations," Working Papers 2010-10, Swiss National Bank.
  2. Lechthaler, Wolfgang & Merkl, Christian & Snower, Dennis J., 2010. "Monetary persistence and the labor market: A new perspective," Journal of Economic Dynamics and Control, Elsevier, vol. 34(5), pages 968-983, May.
  3. Van Beveren, Ilke & Bernard, Andrew B & Blanchard, Emily J & Vandenbussche, Hylke, 2011. "Carry-along trade," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/387875, Katholieke Universiteit Leuven.
  4. Joachim Keller, 2008. "Agency problems in structured finance – a case study of European CLOs," Working Paper Document 137, National Bank of Belgium.
  5. Gerhard Rünstler, . "Shirking, Endogenous Lay-off Rates and the A-cyclicality of the Real Wage," WIFO Working Papers 350, WIFO.
  6. Bernard, Andrew B & Van Beveren, Ilke & Vandenbussche, Hylke, 2010. "Multi-product exporters, carry-along trade and the margins of trade," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/387848, Katholieke Universiteit Leuven.
  7. Abraham, Filip & Van Hove, Jan, 2010. "Can Belgian firms cope with the Chinese dragon and Asian tigers? The export performance of multi-product firms on foreign markets," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/330214, Katholieke Universiteit Leuven.

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